Joe Cahill On Business

What's up at United? Hope, if not profit.

United Continental Holdings is gaining altitude as its profit plummets.

Operating earnings at the Chicago-based airline fell 20 percent in the second quarter, largely due to a 43 percent jump in fuel costs. Still, its second-quarter report brought signs that CEO Oscar Munoz and President Scott Kirby have found the right strategy to turn around the long-struggling airline. After Kirby came aboard two years ago, United ramped up growth by adding flights to bolster its hubs around the country.

Kirby's game plan runs the risk of boosting costs with no guarantee of corresponding revenue increases. That could put more pressure on United Continental's subpar profit margins. For years, the Chicago-based carrier has posted operating profit margins in the high-single-digit to low-double-digit range, while archrival Delta Air Lines routinely reports mid-teen or higher percentages. As a result, United's stock has traded at a discount to Delta's.

Revenue growth came through in a big way during the second quarter, as United's top line climbed nearly 8 percent, to $10.78 billion, amid strong air travel demand. Passenger revenue per available seat mile, a closely watched airline performance measure known as PRASM, rose a strong 3 percent. "We're very happy that early returns from our commercial operations and growth initiatives are really showing up in our results," Kirby told analysts on United's second-quarter earnings call July 17.

Munoz, for his part, was happy to tout improvements in customer service after a series of fiascoes battered United's public image in recent years. On the call, he extolled United's "industry leading on-time departures."

Wall Street forgot its long-standing fixation with airline operating margins and bid up United shares 9 percent as analysts found plenty to like in the numbers. Closing at $80.59 a share yesterday, the stock is up nearly 20 percent for the year. That's better than a year-to-date rise of 5 percent for the broader stock market, and declines of 5 percent and 27 percent for Delta and American Airlines, respectively.

Net income dropped almost 17 percent to $684 million in the quarter, though earnings per share beat estimates. But the stock market reaction was as much about future expectations as quarterly results. United raised full-year earnings guidance by 25 cents per share and boosted its forecast of third-quarter PRASM growth to a range of 4 to 6 percent. Perhaps more important, Munoz and Kirby allayed a range of Wall Street concerns.

On fuel costs, Munoz said United is recovering about 75 percent of the higher prices through fare hikes and cost cuts. He also noted a decline in average nonfuel expenses. "Our performance and financial outcome in the second quarter has increased our confidence that we can offset the higher fuel prices the industry is facing," he said.

In another encouraging development, United is attracting more business travelers, a lucrative market segment critical to airline profits. Many corporate flyers defected to rivals when United's on-time performance and customer service deteriorated. "Corporate revenues were up double digit year over year,'' in the second quarter, said Chief Commercial Officer Andrew Nocella.

United also made clear that it won't pursue growth at all costs. The company rattled Wall Street in January by forecasting 4 to 6 percent growth in available seat miles, a measure of flying capacity. United reduced the top end of that range to 5 percent on July 17, the second cut since January. Kirby pointed out that the airline already has trimmed some flights in response to rising fuel costs and promised more cutbacks if economic conditions warrant.

That's welcome news for those who worry about United's strategic direction. Amazon notwithstanding, profit growth remains the primary measure of business success. United's second-quarter numbers were a step backward for profitability, even as the company made progress elsewhere. Munoz and Kirby can call their strategy successful when profits start rising alongside revenue.